Fintech charter: Be wary of innovating into another crisis

Fintech charter: Be wary of innovating into another crisis
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The Treasury Department released a long-awaited report on financial technology (fintech) firms on Tuesday. As expected, the document advocates a light-touch approach for fintech regulation. After all, no one wants to stifle innovation.

But before we allow fintech firms to bound over the regulatory mound, it’s important to take a hard look at why we regulate the financial services sector so thoroughly to begin with.

Fintech firms include payment companies like Venmo and Square and credit firms like SoFi and Lending Club. Fintech firms also include distributed ledger technology companies built on blockchain-like technology.

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Since its inception, the fintech sector has enjoyed a tremendous amount of hype. From Wall Street to Silicon Valley, fintech is seen as the future of finance. Founders breathlessly claim that their platforms will change or “disrupt” everything and that banking and financial services will never be the same.

 

Many also claim that fintech will bank the unbanked and lead to financial inclusion. The only thing standing in the way of all of this change and disruption, many claim, is overbearing government regulation.

Under the current state of affairs, these companies are regulated by various state and federal agencies. Like other financial firms, these companies must abide by laws regulating money transmission, fair lending, disclosure and other anti-fraud and consumer protection guidelines.

The solution to this regulatory problem, so argue some in the fintech industry, is the creation of a more customized regulatory regime.

To that end, the approach announced by the Trump administration is the creation of a nation-wide special purpose charter for fintech companies. Indeed, the Office of the Comptroller of the Currency (OCC) has announced that it would start accepting fintech applications for a new, nationwide nonbank charter.

This charter will grant fintech companies the status (and privileges) of a “national bank”— including the ability to ignore state interest rate caps and some other state consumer protections — even if these companies are not engaged in the type of deposit-taking activities that are traditionally associated with banks.

But before things take off, it’s important to take a step back from fintech’s utopian promises and consider the reason financial firms are so heavily regulated, which is that there’s a lot at stake when the financial services industry goes south.

Recall that the 2008 financial crisis was only a mere decade ago — a time when “innovative” financial engineering and a hunger for high returns led many to lose their homes, their jobs and their life savings. Bailouts left the taxpayer holding the bag. 

It’s against this backdrop that we ought to view this nonbank charter with some skepticism. The national bank system is premised on the notion that we confer significant benefits on banks in exchange for them providing important financial services to the American people.

Fintech firms, however, do not quite fit into this historical framework. In general, fintech firms do not take deposits, which is a traditional hallmark of banking. Further, the OCC says it will subject fintech firms to the same types of liquidity requirements as banks, which might be quite difficult for the lean tech start-ups that typify the fintech world.

It also puts OCC in the business of trying to ensure that these firms survive, which might not always be appropriate. Additionally, OCC asserts that the nonbank charter will have a financial inclusion component — similar to the Community Reinvestment Act requirements for national banks.

But this may be difficult to do, as fintechs are not tied to specific geographical areas, and it may be difficult to measure financial inclusion for certain types of fintech products. Lastly, the national charter would shield fintechs from many consumer protecting state laws.

Overall, fintechs merit bank-level regulation but not bank-level deference, thus making a national nonbank charter a round hole for only a roundish peg.

So as we move into a world where Wall Street and Silicon Valley become increasingly intertwined, it’s important to balance our hopes for how technology can make life better with our need to maintain a conservative approach to how we address financial regulation.

If fintech really is a brave new world, it requires us to walk carefully and deliberately on this tight rope. No one wants to see us innovate our way into another crisis.

Chris Odinet is an associate professor of law at the University of Oklahoma College of Law and is an affiliate faculty member with the Tom E. Love Division of Entrepreneurship and Economic Development in the University of Oklahoma Price College of Business.